Chapter 23, Problem 1DAP

To determine

a.The level of change in real GDP over the four most recent quarters of data available and the four quarters prior to that.

b. The level of change in real government spending and real taxes over the four most recent quarters of data available and the four quarters prior to that.

c. Provide the explanation to answer part a and part b using the IS and AD curves

Explanation of Solution

a. Real GDP: Real Gross Domestic Product

Real Government Expenditure: Real Government Spending

PCE: Personal Consumption Expenditure

  $\begin{array}{l}\text{Real Taxes }\equiv \underset{}{\text{Taxes}}\times \text{ 100}\\ \text{ PCE}\\ \end{array}$

[of a quarter of current year w.r.t to the prior quarter of previous year]

b.

  $\begin{array}{l}\text{Level of Change in Real Govt}\text{. Spend }\equiv \underset{\_}{{\text{Real Govt Spend}}_2{\text{-Real Govt Spend}}_1}\\ {\text{ Real Govt Spend}}_1\\ \end{array}$

[of a quarter of current year w.r.t to the prior quarter of previous year]

  $\begin{array}{l}\text{Real Taxes }\equiv \underset{\_}{\text{Taxes}}\times \text{ 100}\\ \text{ PCE}\\ \end{array}$

  $\begin{array}{l}\text{Level of Change in Level of Change in Real Taxes }\equiv \underset{\_}{{\text{Real Taxes}}_2{\text{-Real Taxes}}_1}\\ {\text{ Real Taxes}}_1\\ \end{array}$

[of a quarter of current year w.r.t to the prior quarter of previous year]

Year Quarter Month	Real Govt. Spending	Change In Levels of Govt. Spend.	Level of Change in Real Govt Spend %		Real GDP	Change in Levels of GDP	Level of Change in Real GDP %		Federal Govt. Current Taxes Receipts	PCE	Real Taxes =Taxes/PCE * 100	Level of Change in Real Taxes	Level of Change in Real Taxes %
2016 Q1 Jan	2903.1				16571.5				2060	109.9	1874.43
2016 Q2 apr	2896.3				16663.5				2096.2	110.5	1897.01
2016 Q3 July	2899.9				16778.1				2131.5	111	1920.27
2016 Q4 oct	2901.1				16851.4				2112.9	111.5	1894.98
2017 Q1 jan	2896.6	-6.5	-0.22		16903.2	331.7	2.00		2133.3	112.1	1903.03	28.60	1.53
2017 Q2 apr	2895.2	-1.1	-0.04		17031	367.5	2.21		2150.6	112.2	1916.76	19.74	1.04
2017 Q3 july	2899.9	0	0.00		17163.8	385.7	2.30		2176.7	112.6	1933.13	12.86	0.67
2017 Q4 oct	2921.5	20.4	0.70		17286.4	435	2.58		No data	113.4	No data	No data	No data

*St. Louis Reserve Fred Database

Interpretation: Findings -

• Real Government Spending is increasing
• Real GDP is increasing
• Real Taxes are reducing

b. Graphs:

Fig1: Effect of Changes in Government Spending & Taxes On Shifts on Aggregate Demand Curve

Short Run Upward moving Aggregate Supply Curve cuts downward moving Aggregate Demand Curve at point E known as Equilibrium. Here, Gross domestic product (GDP), or (Y), is placed on the horizontal axis, increasing as it stretches to the right. The inflation rate in other words price levels makes up the vertical axis. The SARS [Short Run Aggregate Supply] curve is upward sloping, reflecting the positive relationship that exists between the price level and the number of goods supplied in the short-run. The Long Run Aggregate Supply Curve is a vertical line, reflecting the fact that long-run aggregate supply is not affected by changes in the price level. Due to increase in government spending, the aggregate demand shifts rightward from AD to AD1. When the aggregate demand curve shifts right, the quantity of output demanded a given price level rises from Y to Y1. In effect, the price levels also increase from P to P1. Thus, If the Government increases its spending, that would increase the investments and thereby increases the GDP. Similarly, A reduction in taxes will leave more disposable income and cause consumption and savings to increase, also shifting the aggregate demand curve to the right.

Fig2: Effect of Changes in Government Spending & Taxes On Shifts in IS Curve [Investment Saving Curve]

Short run equilibrium is attained between interest rates and output when IS intersects LM curves at point E. Here, Gross domestic product (GDP), or (Y), is placed on the horizontal axis, increasing as it stretches to the right. The nominal interest rate, or (i or R), makes up the vertical axis. If there is an increase in real government spending then the IS curve would shift to the right. ie. when the government spending goes up [when G goes up] it would shift the IS curve to the right and a new equilibrium is achieved at point E1. In the same way, reduction in taxes also causes the IS curve to shift rightward leading to new equilibrium rate of interest and real GDP. This causes an increase in the rate of interest and real GDP as found in the above table.

Economics Concept Introduction

Introduction:

AD [Aggregate Demand] curve represents the relationship between the inflation rate & aggregate output when the goods market is in equilibrium. The aggregate supply curve depicts the quantity of real GDP that is supplied by the economy at different price levels. The SRAS [Short Run Aggregate Supply] curve is therefore upward sloping, reflecting the positive relationship that exists between the price level and the number of goods supplied in the short-run. The LRAS [Long Run Aggregate Supply] curve is a vertical line, reflecting the fact that long-run aggregate supply is not affected by changes in the price level.

The IS-LM model, which stands for "investment-savings, liquidity-money," is a Keynesian macroeconomic model that shows how the market for economic goods (IS) interacts with the loanable funds market (LM) or money market. It is represented as a graph in which the IS and LM curve intersect to show the short-run equilibrium between interest rates and output. The investment/saving (IS) curve is a variation of the income-expenditure model incorporating market interest rates (demand), while the liquidity preference/money supply equilibrium (LM) curve represents the amount of money available for investing (supply).